non-deposit investment product examination procedures

Rev

iew

cons

umer

com

plai

nts

&re

solu

tions

Off

site

Rev

iew

Exp

ande

dE

xam

inat

ion

Cor

eE

xam

inat

ion

Con

clus

ions

R

epor

t of E

xam

inat

ion

Doc

umen

t saf

ety

& s

ound

ness

con

cern

s.

Ass

ess

polic

ies,

proc

edur

es, &

cont

ract

s

Con

side

rot

her

regu

lato

rs’

findi

ngs

Det

erm

ine

exte

nt o

fN

DIP

sal

esac

tivity

Ass

ess

disc

losu

repr

actic

es &

audi

ts

Sam

ple

acco

unt f

iles

& r

evie

w a

llad

vert

isin

g

Rev

iew

sal

esse

ttin

g po

licy

& c

ondu

ctof

fice

visi

t

Eva

luat

epe

rson

nel &

com

pens

atio

npr

ogra

ms

Exa

min

esu

itabi

lity

prac

tices

and

audi

ts

Ass

ess

inde

pend

ent

revi

ewpr

ogra

m

Sam

ple

inde

pend

ent

revi

ewfin

ding

s

Ver

ifyqu

alifi

catio

ns,

trai

ning

, &co

mpe

nsat

ion

Vis

it m

ultip

leof

fices

&in

terv

iew

staf

f

Sam

ple

acco

unt f

iles

with

Reg

iona

lS

peci

alis

t

Saf

ety

&so

undn

ess

conc

erns

pres

ent?

Cite

vio

latio

ns a

nd c

ontra

vent

ions

. A

ddre

ss m

anag

emen

t & c

ontro

l def

icie

ncie

s. E

nter

Exa

min

atio

n R

esul

ts S

yste

m d

ata.

Com

plia

nce

with

reg

ulat

ions

& p

olic

ies?

Eva

luat

ein

depe

nden

tre

view

prog

ram

Exa

min

atio

n P

roce

ssNONDEPOSIT INVESTMENT PRODUCT EXAMINATIONPROCEDURES

Federal Deposit Insurance Corporation 1 June 1, 1997Division of Supervision

NONDEPOSIT INVESTMENT PRODUCT EXAMINATIONPROCEDURES

Federal Deposit Insurance Corporation 2 June 1, 1997 Division of Supervision

I. INTRODUCTION

A nondeposit investment product (NDIP) is a finan cial asset that is not FDIC-insured and may contain investment risk.NDIPs include mutual funds, annuities, securities, and self-directed Individual Retirement Accounts that invest insecurities. NDIP sales can expand banks’ activities, bolster earnings, increase competitiveness, and providecustomers with additional services. NDIP sales at insured depository institutions may potentially confuse customersand expose banks to contingent liability or reputation risk. In addition, NDIP activity may materially affect banks’earnings or funding structures. Therefore, examiners must carefully evaluate NDIP sales activities.

Several FDIC regulations govern NDIP activity, including minimum recordkeeping and confirmation requirements (Part344), subsidiary and affiliate activities (Part 337.4), and advertisement of membership standards (Part 328). Inaddition, on February 15, 1994, the four federal financial institution regulatory agencies issued the InteragencyStatement on Retail Sales of No ndeposit Investment Products (Interagency Statement). The Interagency Statementapplies to all insured depository institutions engaged in retail NDIP sales, regardless of whether they sell NDIPs directlyor through an arrangement with a third party. The Interagency Statement declares that banks should fully informcustomers about NDIP risks, differentiate NDIPs from insu red deposits, distinguish the NDIP sales area from the retaildeposit area, develop effective program management, and establish independent compliance review.

Notably, the Interagency Stateme nt does not apply to trust activities (when trust powers are exercised), savings bondsales, and government an d municipal security sales in segregated dealer departments. The Interagency Statementapplies to retail NDIP sales effected by trust departments when trust powers are not exercised.

The following guidance enables examiners to efficiently assess adherence to applicable regulations and theInteragency Statement, and to determine any safety and soundness risks that result from NDIP activities. Theexamination procedures emphasize offsite review and automated processes. At examiners’ discretion, theexamination scope for any NDIP area may be expanded to permit more detailed review. However, expansion of theexamination’s scope should be restricted only to the specific areas that require additional scrutiny. Examinationresources should be targeted on specific areas of concern.

II. NDIP CONCEPTS

LAWS, REGULATIONS, AND SUPERVISION

Blue sky laws are state securities laws, which can vary considerably between states.

The Employee Retirement Income Security Act (ERISA) governs most private pension and benefit plans andestablishes pension fund management guidelines. ERISA provis ions apply to self-directed IRAs and Keogh accounts.

The Glass-Steagall Act (Glass-Steagall), enacted in 1933, generally prohibits banks from underwriting securities,engaging in investment banking, or affiliating with investment banks. It also restricts securities firms’ retail bankingactivities.

The Investment Company Act of 1940 requires investment companies to register with the SEC, and establishesrequirements for reporting, pricing, investment allocations, and marketing.

The Investment Advisers Act of 1940 requires all investment advisers to register with the SEC and protects investorsfrom misrepresentation.



The Securities Act of 1933 requires registration of securities offered for public sale, mandates preparation of aprospectus that contains adequate disclosures, and prohibits false statements or fraud.

The Securities Exchange Act of 1934 authorizes the SEC to maintain fair an d orderly securities markets and enforcethe Securities Act of 1933. It also established disclosure, registration, and insider trading requirements.

The National Association of Securities Deal ers (NASD) is the self-regulatory organization for the over-the-countersecurities market. It establishes member qualifications, tests and licenses representatives, maintains Rules of FairPractice, and enforces compliance with securities laws and its own rules (subject to SEC review).

NASD licenses, earned after passing standardized examinations, permit holders to engage in prescribed activities.Several licenses are summarized below:

Series 6: Investment Company and Variable Contract Products Limited Representative, authorized to sell only mutualfunds and annuities.

Series 7: General Securities Representative, may sell all securities except commodities.

Series 11: Assistant Representative - Order Processing, can take and enter unsolicited orders, but can not determinesuitability or provide investment recommendations.

Series 24: General Securities Principal, authorized to supervise all sales personnel.

Series 52: Municipal Securities Representative, may sell only municipal and government securities.

Series 62: Corporate Securities Limited Representative, may sell only corporate obligations.

Regulatory enforcement authority is divided between several banking and securities regulators.

Entity Effecting Primary FederalNDIP Sales Regulator

State Nonmember Bank FDIC

State Member Bank FRB

Bank Holding Company FRB

National Bank OCC

Broker / Dealer SEC & NASD

The Securities and Exchange Commission (SEC) was created by Congress to protect investors, maintain fair andorderly securities markets, and enforce federal securities laws.

The Securities Investor Protection Corporation (SIPC) is a nonprofit membership corporation chartered byCongress to protect brokerage clients should their securities firm declare bankruptcy. Individual investors receive$500,000 coverage for cash and securities held by brokerages (but coverage for cash is limited to $100,000). Thiscoverage does not apply to losses that result from investment risk. Banks are ineligible for SIPC membership, sodirect bank NDIP program customers may not receive SIPC coverage. Bank subsidiaries and affiliates that register



as broker/dealers are eligible for SIPC membership.

Senior Regional Capital Markets and Securities Specialists (SRCMSS) are official FDIC specialists for a broadrange of capital markets topics, including NDIPs, bank investment securities, market risk, and derivatives. OneSRCMSS is assigned to each Region and serves as the primary contact between examiners and the Division ofSupervision’s Secu rities, Capital Markets, and Trust Branch. SRCMSS and other designated examiners, referred toas Regional Capital Markets and Securities Specialists (RCMSS) , receive intensive specialized training. Securities andcapital markets questions, including NDIP concerns, should be directed to a SRCMSS or a RCMSS.

TERMINOLOGY

Annuities are contracts that guarantee income (typically for an individual’s lifetime) in exchange for a lump sum orperiodic payment. The terms are usually based upon the individual’s expected lifetime and anticipated marketconditions.

Deferred annuities guarantee payments at a specified future date and for a specified period.

Fixed annuities are insurance products that guarantee fixed dollar payments, typically until death. The insurancecompany guarantees both earnings and principal. Fixed annuities are generally not considered securities, containcredit risk, and are regulated by state insurance commissioners.

Immediate annuities are purchased with a single premium, and begin paying at once.

Variable annuities guarantee payments, but do not guarantee the payment amounts. Variable annuities are securities,contain investment risk, and investors select level of investment risk.

Bank securities representatives are bank employees who solicit, recommend, and effect NDIP transactions for retailcustomers within an insured depository institution’s direct NDIP program. Bank securities representatives’qualifications and training should substantively satisfy the equivalent NASD license’s requirements. Dual and third-party employees are not bank securities representatives.

Brokers charge a fee or commission for executing customer transactions, or for providing services (for example,investment advice). Federal securities laws exempt banks from the definition of a broker.

Dealers act as a principal in a transaction. A dealer buys or sells a security for its own account and charges thecustomer a premium or discount. Federal securities laws exempt banks from the definition of a dealer.

Discount brokers simply execute transactions and maintain customer accounts, b ut do not provide investment advice.All discount brokerage transactions are unsolicited.

Dual employees are employed by both the bank and a third-party. Management and compensation arrangementsvary, but dual employee programs should be governed by written agreements that clearly describe each party'sresponsibilities.

Full-service brokers provide complete investment services, including investment advice, in exchange for fees orcommissions.

Hybrid accounts , which include sweep accounts, combine elements of insured deposits and NDIPs. The InteragencyStatement’s guidelines generally apply to hybrid accounts.



Independent review functions should be performed by individuals that are not involved in any part of the NDIPoperation. Reviews may be conducted by internal auditors, external auditors, or other independent staffers.

Investment advisers include any individual who offers investment advice in exchange for compensation. Federalsecurities laws exempt banks from the definition of an investment adviser.

Keogh accounts are tax-deferred pension accounts, but are available only to the self-employed or employees ofunincorporated businesses.

Load refers to the sales charge paid by an investor who purchases mutual fund shares or annuities. Front-end loadsare charged at purchase, while back-end loads are charged at sale. However, many funds do not charge sales fees(no-load funds). 12b-1 mutual funds are usually no-load, but assess shareholde rs for promotional expenses. Chargestypically total less than 1 percent of fund assets per year. 12b-1 funds must register with the SEC and disclose theirfees.

Mutual funds are investment companies that register under the Inv estment Company Act of 1940. Mutual funds offertheir own shares for sale or have outstanding shares that are redeemable at the net asset value. All owners sharegains and losses on a pro rata basis. Mutual funds are segregated into two categories:

Open-end funds are sold through a continuous share offering. Share price equals the net asset value, plus any salesfees. Shares are redeemable at the net asset value, less any redemption fees.

Closed-end fund shares are traded like equities, usually on an exchange. The number of shares is fixed, price isdetermined by the secondary market, and shares are not typically redeemed.

Mutual fund administrators perform various services for mutual funds, such as disbursements, auditing, legalcounsel, and information distribution.

Mutual fund distributors are broker/dealers that act as mutual fund agents to sell fund shares. Distributors’responsibilities include SEC registration, prospectus distribution, and marketing.

Mutual fund custodians physically safeguard fund securities.

Net asset value (NAV) represents a mutual fund’s share value. It is calculated by subtracting total liabilities from totalassets, then dividing by the number of outstanding shares. The NAV is calculated once per day, after each asset inthe fund’s portfolio is priced at the market close.

Networking arrangements are formal agreements between banks and third-party vendors that enable vendors tosell or recommend NDIPs on bank premises. A written contract for malizes the arrangement, including compensation,personnel, facilities usage, and other responsibilities.

Private label investment products are NDIPs not affiliated with the bank, but m arketed exclusively through that bank.The investment advisor, administrator, and distributor are not bank affiliates.

Proprietary products are NDIPs that the bank or bank affiliate advises and markets principally to bank or affiliatecustomers.

Sales representatives recommend or sell NDIPs on bank premises. Sales representatives may be NASD-licensedregistered representatives or bank securities representatives.



Self-directed individ ual retirement accounts (IRAs) permit account holders to select the investments held in theiraccounts. Accounts may be designated trustee or custodian accounts, and bank management’s responsibilities varyaccordingly. The Interagency Statement does not apply to self-directed IRAs that are invested entirely in insureddeposits or that are part of a formal trust agreement (trustee accounts).

Securities are financial instruments that grant an ownership position (stocks), a creditor relationship (bonds), or theright to purchase an ownership position (options, rights, and warrants). Sec urities contain investment risk and investorsmay lose part or all of their invested principal.

Sweep accounts include any accounts that employ prearranged, automatic funds transfers (above a preset dollarbalance) from a deposit account to purchase securities. Sweep accoun ts also include accounts that use prearranged,automatic securities sales or redemptions to replenish a deposit account that falls below a preset dollar balance.

Third-party vendors are entities other th an banks that engage in NDIP activity on bank premises. Bank subsidiariesor affiliates engaged in NDIP activities are considered third-party vendors.

Unsolicited transactions occur when customers direct sales representatives to initiate transactions that were notrecommended or suggested by any individual connected with the NDIP operation.

III. PROGRAM MANAGEMENT

Management’s responsibilities depend upon the type and scope of the bank’s NDIP operation. When bank employeessell or recommend NDIPs, management must establish a comprehensive program to control and supervise allaspects of the p rogram’s daily operations. If the bank has a networking arrangement with a third-party vendor, thenmanagement’s responsibilities depend upon the nature and scope of the networking arrangement and management’soversight program for that relationship. Regardless of the type of NDIP operation employed, management mustensure that:

NDIP activity adheres to all laws, regulations, and the Interagency Statement.The NDIP program operates safely and soundly.Customers receive adequate disclosures.

Board OversightThe board shoul d adopt an NDIP statement that addresses the program’s risks and ensures compliance with theInteragency Statement. The NDIP statement should summarize the program’s policies, procedures, and controls.It should clearly define the scope of any third party activities and bank monitoring of third party compliance withapplicable laws, regulations, and the Interagency Statement. The statement should contain detail commensurate withthe NDIP program’s scope. The board should formally adopt the statement, review it periodically, and revise it whenappropriate.

Bank OperationsWhen bank employees recommend or s ell NDIPs, management should adopt a comprehensive NDIP managementprogram. The program should be guided by board policy, include detailed procedures, and receive closemanagement supervision. The board should tailor its NDIP program to the bank’s goals and its customers’ needs.Most important, the board should periodically reassess th e program and, when necessary, modify it to ensure prudentoversight of all NDIP activities. Management’s policies and procedures should:



Ensure compliance with all applicable laws, regulations, and the Interagency Statement.Designate the senior managers responsible for supervising NDIP activity.Designate the employees authorized to recommend or sell NDIPs.Maintain strict separation of duties between NDIP sales, management, and accounting.Establish procedures and criteria for selecting and reviewing the NDIPs offered.Set guidelines for customer information usage.Establish NDIP referral procedures.Detail employee qualification, training, and compensation practices.Ensure that the bank’s blanket bond covers its NDIP activities.Establish a process to document and resolve customer complaints.

Networking ArrangementsPrior to entering into a networking agreement wi th a third-party vendor, management should diligently review the thirdparty’s:

Qualifications Financial conditionExperience References (particularly other banks)Regulatory history

Networking arrangements should be established by a formal, written agreement. The board should periodically reviewits third party agreements to ensure that they meet the bank’s needs and conform to all regulatory requirements.Networking agreements should:

Clearly describe each party’s duties and responsibilities.Define the activities that may be conducted on bank premises.Establish controls for the use of bank space, personnel, and equipment.Establish sales representative qualification requirements.Not preclude management from determining if particular sales representatives are not qualified to be associatedwith the NDIP program.Detail all compensation arrangements for all related personnel.Require the third party to comply with all applicable laws, regulations, and the Interagency Statement.Authorize the bank and appropriate banking agencies to monitor, review, and verify third party compliance andrecords.Indemnify the bank from liability resulting from the third party’s NDIP sales activities.Require written, bank-approved employment contracts for any dual employees.Address the use of customer information and safeguard protected information.

Subsidiaries and AffiliatesNDIP subsidiaries and affiliates are third par ties; therefore, they are subject to all third-party vendor requirements andguidelines. The board’s policies should ensure that the bank complies with Part 337.4 of the FDIC’s Rules andRegulations, which governs bank subsidiaries’ securities act ivities and bank transactions with affiliated securities firms.

Product SelectionManagement should offer NDIPs that meet the bank’s goa ls and anticipated customer needs. Policies should specifythe criteria used to select the NDIPs that will be sold. That proc ess should be scrupulously followed and documented.At a minimum, management should:

Determine if and how products are regulated. Assess each product’s risks, rewards, and long-term performance.



Consider the reputation and financial strength of the issuing or sponsoring company.Periodically review the product mix relative to the bank’s goals and customer needs.

When a consultant or third-party selects or recommends the product mix, management should verify that the selectionprocess includes the above provisions. Further, management should determine if the consultant or third party receivescompensation fro m any product provider. Management should carefully consider any compensation arrangementsbefore offering those products.

IV. PERSONNEL

NDIP programs can not operate safely and soundly without qualified employees. Management should establishformal policies and requirements for bank securities representatives, the bank’s NDIP supervisory personnel, andother bank NDIP program employees. Those policies and requirements should address:

QualificationsTrainingCompensation

QualificationsWhen bank employees recom mend or sell NDIPs, management should ensure that its employees are qualified andadhere to high professional standards. Bank securities representatives should possess qualifications that aresubstantively equivalent to NASD-licensed registered representatives. Man agement should verify each bank securitiesrepresentative’s background with regulatory agencies and prior employers. Securities regulators and self-regulatoryorganizations maintain historical records of disciplinary and f ormal enforcement actions taken against representatives.When a bank securities representative has a history of formal enforcement actions, management should carefullyconsider whether that individual should be associated with the bank’s NDIP program.

When the bank has a networking arrangement with a third party, management should take every reasonableprecaution to verify that sales representatives on bank prem ises are properly licensed, qualified, and professional. Forboth dual employees and third-party employees, management should verify each sales representative’s backgroundwith regulatory agencies and prior employers. When a representative has a history of formal enforcement actions,management shoul d carefully consider whether that individual should be associated with the bank’s NDIP program.

TrainingAll personnel involved in the NDIP program should receive comprehensive training for their duties, including continuingeducation. Sales representatives and investment advisors should fully understand the products offered, and allemployees who have direct customer contact should receive basic NDIP program training. That training shouldaddress compliance with the Interagency Statement, all applicable laws and regulations, and the bank’s salesguidelines.

Bank securities representatives should receive training that is substantially equivalent to the requirements for theappropriate NASD representative designation, including coverage of:

Product and strategy risksApplicable laws and regulationsCustomer protection requirements

Bank personnel who supervise NDIP activity should receive sufficient training to effectively manage the sales



representatives. NDIP program supervisors should receive training appropriate to that position.

CompensationBanks may compensate employees for NDIP customer referrals, but the compensation must be:

A one-time, nominal fee.A fixed dollar amount for each referral.Paid regardless of whether a sale or new account results.

For example, a bank may pay a fixed dollar fee for every confirmed NDIP customer referral. However, the fee cannot be increased if the customer purchases an investment or opens an account. Likewise, the fee can not be reducedif the customer does not purchase an investment or open an account. The referral compensation guidelines applyto all employees that are not specifically authorized to sell or recommend NDIPs.

Sales representatives may receive commissions or incentives for customer transactions, but incentives must notencourage or result in unsuitable recommendations, improper sales, or excessive account transaction activity. Further,independent review personnel or audit staff should never receive incentive compensation related to NDIP sales.

V. DISCLOSURES

Management should ensure that sales r epresentatives and other employees clearly differentiate NDIPs from insureddeposits for customers, regardless of the type of NDIP program in place (including networking arrangements). TheInteragency Statement declare s that NDIP sales disclosures should, at a minimum, clearly indicate that a product is:

Not insured by the FDIC.Not a bank deposit, bank obligation, or guaranteed by the bank.Subject to investment risk, including potential principal loss.

However, the Interagency Statement disclosures do not apply to:

Radio broadcasts of 30 seconds or less.Electronic signs (excluding television, internet, or ATMs).Signs used only as location indications.

Customer Accounts Customers should receive the minimum disclosures during every NDIP sales presentation. Oral disclosures maysuffice during many sales presentations and when investment advice is offered. However, when a customer opensan investment account, the sales representative should:

Provide clear written and oral disclosures.Fully detail any fees, penalties, or redemption charges.Obtain a signed customer statement that acknowledges the customer’s receipt and understanding of all disclosures.Disclose all material relationships between the bank and any third-party vendors (refer to the Material Relationshipssection below).

If transaction confirmations or account state ments contain the bank (or affiliate) name or logo, then those documentsshould also include at least the minimum disclosures. If customers’ periodic deposit account statements also includeNDIP account information, then the NDIP account information should be separ ate and distinct from the insured deposit



account information. In addition, the statement should contain at least the minimum disclosures and identify the entitythat conducted the NDIP transactions (if the bank used a third-party broker/dealer).

Advertising and Promotion All retail NDIP advertising and promotions should include the minimum disclosures, and must not misrepresent aproduct’s risks or lack of FDIC insurance. If advertising or promotional material addresses both insured deposits andNDIPs, then the NDIP information and disclosures should be separate and distinct from the insured depositinformation. Further, the official FDIC membership statement described in Part 328 of the FDIC’s Rules andRegulations should not be used in any NDIP advertising or promotional material. The minimum disclosures apply,but are not limited, to:

Advertising (all media, including internet) Telemarketing and electronic contactsPromotional displays on bank premises Third-party vendor promotional materialBrochures and other informative materials

Shorter, logo format disclosures may be used for visual media, including televi sion, ATMs, billboards, signs, brochures,and other written promotional materials. Acceptable logo disclosures should include the following statements:

Not FDIC InsuredNo Bank GuaranteeMay Lose Value

Third-party vendors, mutual funds, and other NDIP providers will often supply banks with promotional materials, suchas placards, brochures, and signs. However, the Interagency Statement’s disclosure standards are uniform and donot vary depending upon the entity that produced the material. All NDIP advertising and promotional materialdisplayed on bank premises or provided to customers through ba nk channels, regardless of its source, should containthe minimum disclosures.

Material Relationships Sales representatives should disclose significant relationships between the bank, affiliates, and investment firms.Material relationships that should be disclosed include those between:

Banks or affiliates and an investment company, when the bank or affiliate sells its shares.Banks and NDIP sales affiliates.Banks or affiliates and proprietary products.

Other Insurance Coverage Whenever sales activities include a representation regarding insur ance coverage not provided by the FDIC, customersmay confuse that coverage with FDIC insurance. For example, certain inves tments may be covered by the SIPC, stateinsurance funds, or private insurance firms. Sales representatives should clearly distinguish FDIC insurance from anyother type of insurance coverage.

Bank and Product Identity NDIPs must not have a name that is precisely identical to the bank’s name. When the bank offers products withnames similar to the bank, management should take precautions to prevent customer confusion. Management shouldensure that those products are clearly differentiated from the bank’s insured deposit products.

Transaction NotificationPart 344 of the FDIC’s Rules and Regulations establishes minimum confirmation and recordkeeping requirements



for banks that sell securities. When a customer purchases a security, the bank must provide either a copy of thebroker/dealer confirmation or a written notification of the transaction. Part 344.5 details the information that eachnotification must contain.

The bank must disclose the amount of any compensation that it received from the customer for each transaction.Further, when the bank receiv es compensation from any other source for the transaction, then the bank must either:

Disclose the source and amount of compensation on the transaction notification.Include a statement on the transaction notification disclosing that the bank received such compensation and thatit will provide the source and amount upon the customer’s written request.

VI. SALES SETTING

In order to minimize customer confusion between NDIPs and insured deposits, management should carefully planthe NDIP sales setting and customer contact procedures. Poorly designed sales settings and contact procedures canmagnify customer confusion and expose the bank to risk. First, management must physically distinguish the areawhere NDIPs are sold or recommen ded from the area where insured deposits are accepted. Second, managementshould establish procedures for NDIP discussions, referrals, and inquiries that occur outside the designated NDIPsales areas. Bank management is responsible for pl anning and maintaining the NDIP sales setting, regardless of thetype of sales operation in place.

Physical Location All NDIP sales and recommendations should be conducted in a location that is physically distinct from the retaildeposit area. Signs or other indicators should conspicuously identify and segregate the NDIP sales area. Confinedfacilities or limited lobby space may restrict management’s options. In such cases, management should carefullydistinguish NDIP activity from retail deposit activity.

Signs for the retail deposit area should not address NDIPs, except for directional indicators. Insured deposit rateboards should not include NDIP information. Rate boards that address NDIPs may be subject to detailed securitieslaws regarding investment yield advertisements.

Referrals and InquiriesManagement should establish written customer contact procedures for employees that do not sell or recommendNDIPs (for example, tellers and deposit account representatives). All employees with customer contact responsibilitiesshould receive NDIP customer contact procedure training.

Within retail deposit areas, employees should never offer NDIP recommendations, qualify customers for NDIPpurchases, or accept NDIP orders. Such activities may blur the distinction between insured deposits and NDIPs.However, any bank employee can refer customers to authorized NDIP sales or advisory personnel.

Within some NDIP programs, bank employees sell both NDIPs and insured deposits. Management should ensurethat those employees receive sufficient training to clearly disclose NDIP risks and explain the differences betweenNDIPs and insured deposits to customers.

VII. SUITABILITY

Sales representatives must employ fair and reasonable investment recommendation and sales methods .



Representatives must base all investment recommendations on reasonable, objective analysis of each customer’sfinancial condition and investment goals. Employees that are not authorized sales representatives should notrecommend specific NDIPs or suggest investment strategy. The board should establish an effective independentreview process that regularly assesses sales and investment recommendation practices, regardless of the type ofNDIP program in place (including networking arrangements).

Investment Recommendations Sales representatives should exercise care when recommending investments to retail customers. First,representatives should obtain information detailing each customer’s investment goals, financial condition, and otherfactors. That information should be documented and periodically updated. Next, representatives should evaluate thatinformation, compile customer profiles, and develop reasonable support for all recommendations. Finally,representatives should clearly explain all recommendations to customers.

Representatives can not prudently recommend specific strategies or investments without first evaluating acustomer’s financial condition and investment goals.

Customer investment goals should serve as the basis for all recommendations, especially:

Risk tolerance Tax considerationsReturn objectives Liquidity

Customer financial information should be evaluated, including:

Assets, liabilities, and net worth TaxationIncome and expenses InsuranceInvestment portfolio composition

Customer nonfinancial factors should also be considered, including:

Age and retirement plans Current and anticipated education needsFamily status Current and anticipated health care needs

Unsolicited TransactionsSuitability standards are less stringent for unsolicited transactions and discount brokerage operations. In suchcircumstances, the sales representative should ensure that the customer has received at least the minimum NDIPand new account disclosures before accepting the transaction. Also, the bank should retain documentation(preferably signed by the customer) that shows the transaction was initiated solely at the customer’s request.

Third-Party Vendors Management should make reasonable efforts to ensure that third-party employees comply with all applicableregulations, the vendor’s policies, and bank policies. Management should periodically review regulatory reports (forexample: NASD and SEC examination findings), third-party audit reports, and other available materials. In addition,management should carefully review all customer complaints and re solutions. Further, management should evaluatesales representative turnover at bank locations. High complaint or turnover volume may indicate program difficulties.Material problems should be reported to the board, addressed with the vendor, and resolved.



VIII. PROPRIETARY PRODUCTS

Proprietary products are NDIPs that the bank or bank affiliate advises and markets principally to bank or affiliatecustomers. Proprietary products can produce greater income for banks than off-t he-shelf products, but can also creategreater risk exposure. These products expose banks to increased reputation risk, create liquidity and capitalconsiderations, and magnify disclosure concerns. The board and management should adopt detailed policies andprocedures to control proprietary products sales.

Program Management The board should establish policies that guide the management and operations of any proprietary products, andshould maintain prudent oversight of proprietary product operations. This oversight should apply to all proprietaryproducts, including those advised by an affiliate. The policies should:

Require separation of duties between trading, sales, management, and accounting.Define bank management’s responsibilities.Establish an independent review function.Outline strategies for potentially significant events, such as a capital injection.

Disclosure When selling or recommending proprietary NDIPs, sales representatives should clearly disclose the product’s risksto customers. Representatives should disclose th e minimum information described in subsection V, Disclosures, andshould also inform customers of:

Additional compensation earned for selling a proprietary product rather than other products.The product’s fee structure, relative to other products offered at the bank.The product’s risk profile, relative to other products offered at the bank.The product’s historical performance, relative to other products offered at the bank.

IX. IRAs AND KEOGH ACCOUNTS

Generally, IRAs and Keogh accounts are trust accounts. When offered through a trust department, those accountsshould be reviewed during trust examinations. Certain types of IRAs and Keogh accounts require trust powers,including:

Accounts that appoint the bank as trustee.IRAs established by an employer for its employees.Keogh accounts that cover additional employees.

Banks may, without exercising trust powers, offer self-directed custodial accounts that are established by individualsfor their own benefit. Customers may then choose to invest account funds in NDIPs. Those activities are subject tothe Interagency Statement’s guidelines and must be examined during regular safety and soundness examinations.

When banks offer and service self-directed IRAs or Keogh accounts, the Interagency Statement’s guidelines applyto program management, personnel, disclosures, sales setting, and independent review apply. In addition, the specialnature of these accounts demands additional management and control processes.



Asset and accounting controls must segregate customer assets from bank assets (in both bank and correspondentfacilities). Each individual account’s assets must be distinguished from other accounts’ assets. Accounting recordsmust clearly reflect that segregation, and must be separate from the bank’s general ledger. Accounting controlsshould facilitate proper income reporting, record asset types, and identify individual instruments. Assets held at thebank must be under dual control and sho uld be periodically reconciled or verified. If the bank establishes a nomineepartnership for securities registrations and transfers, then management should register the nominee name with theAmerican Society of Corporate Secretaries. This safeguard prevents problems that could occur if more than one bankuses the same nominee name.

Documentation must clearly identify and support each account. IRA documentation should include, at a minimum,the required IRS trust/custodian agreement (Form 5305, 5305A, or equivalent), consumer disclosure agreement,signature card(s), and beneficiary designation.

Suitability guidelines should not apply to self-directed IRAs and Keogh accounts, since all transactions should beunsolicited. If the bank offers investment advice to the customer or acts as trustee, then the account is not self -directed. Management should implement procedures to document or verify that customers do not receive anyinvestment recommendations from the bank.

Illegal investments must not be permitted, regardless of any contrary customer instructions. IRA funds may beinvested in United States American Eagle gold coins, but not in collectibles, including art, precious metals, gems,stamps, or antiques. In addition, IRA funds must not be used for certain insider transactions, including:

Loans to the account sponsor or beneficiaries.Collateral for loans to the account sponsor or beneficiaries.Purchasing assets from the account sponsor, beneficiaries, or custodian bank.Selling assets to the account sponsor, beneficiaries, or custodian bank.Investments in debt instruments of the custodian bank or its holding company.Investments in equity securities of the custodian bank or its holding company, unless acquired from an independentthird-party at fair market value.

Broker selection must be based upon two principles. First, management must select the best broker for the account.Second, under SEC Rule 28(e), brokers must be selected based solely on the combination of lowest possiblecommission and best possible order executio n. Management may not select a broker based on insider relationships,personal relationships, compensation of any type, or solely due to community ties.

Bank brokerage operations present conflicts of interest and considerable risk. A bank can only use its own bankbrokerage services for custodial and trustee accounts when:

Management satisfies securities laws relative to broker selection.The customer receives full written disclosure (pursuant to FDIC General Counsel’s Opinion Number Six) of thebank’s or affiliate’s relationship to the broker and all compensation that the bank will earn.The account agreement expressly authorizes the specific activity.The bank complies with Part 337 of the FDIC’s Rules and Regulations, which states that the transactions must becomparable to transactions with an unaffiliated broker/dealer.The bank complies with ERISA and Internal Revenue Code provisions stipulating that the bank must either chargeno fees, or only charge fees that recover direct costs.The bank automatically uses its brokerage for all transactions unless re quested to do otherwise, but provides 30-dayadvance notice to accounts of all fee increases and permits accounts to immediately cease using the banksbrokerage without penalty.



Independent review functions, in addition to the minimum NDIP guidelines, should:

Reconcile deposit and suspense accounts.Verify assets and recordkeeping.Test physical safekeeping and dual control.

When banks offer self-directed IRAs and Keogh accounts but a third-party servicer administers the accounts, theboard and management should implement a comprehensive program that adheres to the Interagency Statement’sguidelines. Prior to selecting a third-party servicer, the board should evaluate servicers’:

Reputation and experienceFinancial strengthRegulatory historyCapacity to service anticipated volumeService costs

Management should continue to regularly monitor its servicer, and those reviews should not occur only in preparationfor contract renewal. All third-party servicer arrangements should be controlled by a board-approved, writtenagreement that:

Permits the bank to review the servicer’s regulatory reports and internal audit findings.Permits the bank to obtain the source paper files related to its accounts if servicing is terminated.Requires the servicer to provide all related computer records in a format compatible with bank and successorservicer systems.

X. INDEPENDENT REVIEW

The board must ensure that NDIP activities comply with all applicable laws and regulations, the InteragencyStatement, and bank policies. Independent review depth and scrutiny should depend upon the type of sales programused. Depending upon a bank’s size and NDIP activity, an effective independent review program may:

Evaluate customer complaints and resolutions.Analyze exception reports that monitor sales and sales representatives’ performance.Assess sales representative turnover.Investigate unusual redemption patterns.Sample customer account files to verify disclosure, suitability, and activity practices.Interview customers.Employ testers to check disclosure and suitability practices.

When bank employees sell or recommend NDIPs, independent review should also:

Identify potential conflicts of interest.Review separation of duties between sales, supervision, and accounting functions.Review suitability processes and sample investment recommendations.Evaluate proprietary product operations.



When the bank has a networking arrangement, independent review should also:

Ensure that both parties adhere to the written agreement’s terms and conditions.Verify that third party practices conform with FDIC regulations, the Interagency Statement, and bank policies.

The independent review should be completely separate from the NDIP operation. Independent review staff shouldnot receive any compensation that is based on NDIP sales activity. Review scope and frequency should bedetermined by independent staff. Findings should be reported directly to the board or a designated board committee(for example, the Audit Committee). Internal and external audit programs should also incorporate NDIP reviewprocedures.

XI. CORE EXAMINATION PROCEDURES

The NDIP examination procedures’ two-tier approach maximizes offsite revi ew, streamlines examinations, and focusesresources on potential risks. The procedures permit examiners to verify compliance with the Interagency Statementand applicable regulations. In addition, the procedures enable examiners to evaluate the potential impact of NDIPactivity on banks’ safety and soundness. There are no questionnaires or checklists that must be completed duringan NDIP examination.

The core examination procedures apply to all bank NDIP sales programs. When material violations, weaknesses,or risks are evident, consider implementing the expanded examination procedures for that area. However, expandedprocedures should only be implemented for the specific areas that cause examiner concern.

Use judgement and discretion to determine when the examination’s scope should be expanded.

OFFSITE REVIEW The offsite review process incorporates many NDIP examination elements. Many examination procedures may becompleted more efficiently during the offsite review, which also reduces the examination resources expended in banks.Obtain all available NDIP information from the bank prior to beginning the examination, including:

Bank policies and procedures Customer disclosure formsAgreements with third parties Training programs materials and recordsIndependent review policies and reports Other regulatory reportsNDIP activity and financial reports Qualifications of all NDIP program personnelAll available promotional materials Proprietary product management reportsCustomer complaints and resolutions

Other regulators’ reports and findings should be obtained from the bank. When necessary, under a 1995Memorandum of Understanding between the FDIC and the NASD, FDIC examiners can obtain the examinationfindings and workpapers from the most recent NASD examinations of bank-affiliated broker/dealers. FDIC RegionalOffices are responsible for contacting the appropriate NASD regional office and establishing information sharingprocedures. NASD information should be requested prior to beginning pre-examination planning to ensure that it isavailable for offsite review. Use the above material to complete as many of the following examination procedures aspossible before commencing the onsite examination.

PROGRAM MANAGEMENTThe board and management should adopt, implement, and maintain an effective NDIP program. Refer to subsectionIII, Program Management, for additional information. Evaluate the board’s oversight and control of the NDIP program.



Sales confirmations Advertising and promotional material

Verify that the NDIP program mandates at least the minimum disclosures. Review the written policies, procedures,and independent review reports. Written policies and procedures should require:

Disclosure training for all NDIP personnel.Minimum disclosures during all NDIP sales presentations.Minimum disclosures for all NDIP advertising and promotions.Representatives to obtain a signed customer statement that acknowledges the customer’s receipt andunderstanding of all disclosures before opening a new account.Comprehensive independent review.

Review all customer complaints in the NDIP program’s files and in FDIC files. Determine if the complaints suggesta pattern of inadequate disclosure. If such a pattern is evident, then imple ment the expanded examination procedures.

The core procedures do not include customer account file review. When file review appears necessary, implementthe expanded procedures (which incorporate customer account file review). Use judgement and discretion todetermine when to implement the expanded procedures.

If the board and management have not adopted effective policies and procedures to provide at least the minimumdisclosures, then implement the expanded examination procedures. Further, if th e independent review reports suggestthat the NDIP customers do not receive adequate disclosures, then implement the expanded procedures.

SALES SETTINGManagement must take every reasonable precaution to eliminate customer confusion between the NDIP and retaildeposit settings and operations. Refer to subsection VI, Sales Setting, for additional information. When examiningthe NDIP sales setting:

Verify that policies and procedures require strict segregation between NDIP and retail deposit activity.If hybrid accounts are offered, determine if management has established clear written policies and controls.Verify that NDIP names are not identical to the bank’s name.Determine if the training program provides education regarding maintainin g segregation between the NDIP and retaildeposit areas.Determine if the NDIP sales areas are clearly segregated from retail deposit areas. In banks with multiple NDIPsites, evaluate a small sample of the NDIP sales locations.Verify that the independent review reports address the NDIP sales setting and that exceptions have been corrected.Review all customer complaints and determine if they indicate a pattern of consumer confusion regarding NDIPsales settings.

When management has not established NDIP sales areas that are physically distinct from the retail deposit areas,implement the expanded procedures.

SUITABILITYSales representatives can not prudently recommend specific investments without evaluating a customer’s financialcondition and investment goals. Evaluate management’s policies and controls, independent review, and customercomplaints, rather than samples of i ndividual recommendations to customers. Refer to subsection VII, Suitability, foradditional information. Determine if:

Customer complaints indicate a pattern of unsuitable recommendations.



Policies and controls require represe ntatives to evaluate sufficient customer information before offering investmentrecommendations.Policies and controls require representatives to clearly explain all recommendations to customers.The independent review includes thorough suitability coverage.

The core procedures do not include customer account file review. When file review appears necessary, implementthe expanded procedures (which incorporate customer account file review). Use judgement and discretion todetermine when to implement the expanded procedures.

If the suitability policies, controls, or practices demonstrate weakness or indicate customer confusion, then implementthe expanded examination procedures.

PROPRIETARY PRODUCTSThe board should oversee all proprietary product activities and establish policies that guide the management andoperations of any proprietary products. Sales representatives should understand the proprietary products and clearlydisclose those products’ risks, fees, and commissions to customers. Independent review should verify soundoperations and appropriate disclosures. Refer to subsection VIII, Proprietary Products, for additional guidance.

Determine if the proprietary products present potential risks by:

Evaluating policies, procedures, board oversight, and management supervision.Reviewing other regulatory reports for findings that may affect the bank’s safety and soundness.Verifying that policies and procedures require sales representatives to clearly disclose proprietary products’ risks,fees, and commissions.Determining independent review adequacy.

If proprietary products have inadequate board oversight, management, sales disclosures, or independent review, thenimplement the expanded examination procedures.

INDEPENDENT REVIEWIndependent review should ensure that the NDIP program complies with all laws, regulations, the InteragencyStatement, and internal policies and procedures. Refer to subsection IX, Independent Review, for additionalinformation. Determine if the independent review:

Maintains complete independence from the NDIP program.Identifies potential conflicts of interest.Monitors customer complaints and resolutions.Verifies that third-party sales adhere to the agreement with the bank, applicable laws and regulations, and theInteragency Statement.Ensures that disclosure policies, procedures, and content comply with applicable laws, regulations, and theInteragency Statement.Samples customer files to verify that signed disclosure statements are obtained.Reviews all advertising and promotions for compliance with applicable laws, regulations, and the InteragencyStatement.Scrutinizes the suitability process and sample customer account files.Evaluates proprietary product operations.Compiles regular reports.



Reports directly to the board or designated committee.

If the independent review function does not adequately assess and report compliance to the board, then implementthe expanded examination procedures.

XII. EXPANDED EXAMINATION PROCEDURES

The expanded examination procedures direct increased scrutiny on specific areas of NDIP activity that presentadditional risk. The entire set of expanded procedures should not be applied automatically. Rather, implement onlythe expanded procedures that address specific areas of weakness, concern, or potential risk.

When material supervisory concerns are evident, consider contacting a SRCMSS or RCMSS for additionalguidance.

PROGRAM MANAGEMENT When the core examination procedures identify NDIP program weaknesses , those weaknesses may negatively impactthe bank’s safety and soundness. Discuss all weaknesses in detail with management, suggest corrective action, andassess management’s commitment to correct all deficienci es. If NDIP program management creates potential safetyand soundness risk or management is unwilling to correct the program’s deficiencies, then formal corrective actionmay be warranted.

PERSONNELWhen management’s policies, procedures, and independent review do not appear to provide for a qualified, well -trained NDIP staff:

Review sales representatives’ files and assess their bac kgrounds and regulatory histories. If management does notmaintain that information on file, they should obtain it for the examination and for internal review.Assess the bank’s NDIP training materials.Sample compensation practices to verify that management adheres to all applicable laws, regulations, theInteragency Statement, and board policy.Review sales records and ensure that only specifically designated personnel sell NDIPs.Review referra l practices and verify that management adheres to all applicable laws, regulations, the InteragencyStatement, and board policy.Interview various branch employees, including tellers and receptionists, and determine if proper NDIP referralprocedures are followed.Discuss all concerns with management and determine their commitment to correct any deficiencies.

DISCLOSURESWhen the core procedures indicate that customers may not receive adequate NDIP disclosures:

Sample customer account files and verify that the required disclosures are included.Review all available advertising and promotional material.Visit several NDIP sales location s (when practical), evaluate the NDIP promotional material, and sample customerinformation.Interview sales representatives and gauge their knowledge of and commitment to adequate disclosure.Discuss all concerns with management and determine their commitment to correct any deficiencies.

Do not pose as a potential NDIP customer or employ testers in order to assess the disclosure process. When a



pattern of inadequate disclosure is evident, corrective action may be warranted.

SALES SETTINGWhen the core proc edures indicate that the NDIP sales setting may create customer confusion between NDIPs andinsured deposits:

Visit additional NDIP sales locations (when practical) and determine if the NDIP sales setting is physically distinctfrom the retail deposit area.Discuss all concerns with management and determine their commitment to correct any deficiencies.

When the sales settings do not clearly distinguish the NDIP sales area from the insured deposit area, assess thepotential for customer confusion.

SUITABILITYImplement these procedures when the core procedures reveal that suitability practices or controls create customerconfusion or potential risk. Assess the extent of s uitability problems and potential risk exposures, but do not judge theappropriateness of individual recommendations to customers or suggest alternatives. Contact a SRCMSS or RCMSSfor guidance before commencing these expanded suitability procedures.

Analyze sales reports and promotions to:

Evaluate sales activity for questionable practices, such as account churning.Determine if promotions have prompted unsuitable recommendation practices. For example, high volumes ofvolatile instruments or dramatic increases in a particular product’s sales may indicate suitability concerns.

Sample customer files and determine if:

Customers signs appropriate disclosure forms.Representatives document and review adequate customer information before offering investmentrecommendations.Customer data has been updated periodically.Representatives provide complete information to customers regarding potential risks.Recommendations conform to customer goals.

Determine the potential risk from customer confusion or unacceptable investment recommendation practices. Donot pose as a potential NDIP customer or employ testers in order to assess the suitability process. Discuss allconcerns with management and determine their commitment to correct any deficiencies.

PROPRIETARY PRODUCTSWhen the core procedures indicate that a proprietary product may create potential risk:

Sample customer account files and verify that proper disclosures are included .Evaluate management’s policies, procedures, and ability relative to potential cash injections or liquidity problems.Analyze other regulatory reports (for example, NASD, SEC, or state insurance commissioner examinations) toassess any operational risks.

INDEPENDENT REVIEWWhen core examination procedures illustrate inadequate independent review:



Incorporate the NDIP analysis into the safety and soundness assessment, including the composite rating and allapplicable component ratings. Material NDIP findings and analysis may be included in the Examiners Conclusionsand Comments. Address any NDIP pro gram deficiencies in the Management and Administration, Risk Management,Internal Routine and Controls, and Violations sections of the Report of Examinations.

APPARENT SECURITIES LAW VIOLATIONSApparent violations of securities laws by bank-affiliated broker/dealers should be referred to the NASD. Each FDICRegional Office has the responsibility for providing this information to the appropriate NASD regional office.

non-deposit investment product examination procedures

Documents